Intangible Assets

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Chapter 12 Intangible Assets

QUESTIONS

1. What are the two main characteristics of intangible assets?
2. If intangibles are acquired for stock, how is the cost of the intangible determined?
3. Intangibles have either a limited useful life or an indefinite useful life. How should these two different types of intangibles be amortized?
4. Why does the accounting profession make a distinction between internally created intangibles and purchased intangibles?
5. In 2012, Ghostbusters Corp. spent $420,000 for “goodwill” visits by sales personnel to key customers. The purpose of these visits was to build a solid, friendly relationship for the future and to gain insight into the problems and needs of the companies served. How should this expenditure be reported?
6. What are factors to be considered in estimating the useful life of an intangible asset?
7. What should be the pattern of amortization for a limitedlife intangible?
8. Columbia Sportswear Company acquired a trademark that is helpful in distinguishing one of its new products. The trademark is renewable every 10 years at minimal cost. All evidence indicates that this trademark product will generate cash flows for an indefinite period of time. How should this trademark be amortized?
9. McNabb Company spent $190,000 developing a new process, $45,000 in legal fees to obtain a patent, and $91,000 to market the process that was patented, all in the year 2012. How should these costs be accounted for in 2012?
10. Izzy Inc. purchased a patent for $350,000 which has an estimated useful life of 10 years. Its pattern of use or consumption cannot be reliably determined. Prepare the entry to record the amortization of the patent in its first year of use.
11. Explain the difference between artistic-related intangible assets and contract-related intangible assets.
12. What is goodwill? What is negative goodwill?
13. Under what circumstances is it appropriate to record goodwill in the accounts? How should goodwill, properly recorded on the books, be written off in order to conform with generally accepted accounting principles?
14. In examining financial statements, financial analysts often write off goodwill immediately. Comment on this procedure.
15. Braxton Inc. is considering the write-off of a limited-life intangible because of its lack of profitability. Explain to the management of Braxton how to determine whether a write-off is permitted.
16. Last year Zeno Company recorded an impairment on an intangible asset held for use. Recent appraisals indicate that the asset has increased in value. Should Zeno record this recovery in value?
17. Explain how losses on impaired intangible assets should be reported in income.
18. Simon Company determines that its goodwill is impaired. It finds that its implied goodwill is $360,000 and its recorded goodwill is $400,000. The fair value of its identifiable assets is $1,450,000. What is the amount of goodwill impaired?
19. What is the nature of research and development costs?
20. Research and development activities may include (a) personnel costs, (b) materials and equipment costs, and (c) indirect costs. What is the recommended accounting treatment for these three types of R&D costs?
21. Which of the following activities should be expensed currently as R&D costs? (a) Testing in search for or evaluation of product or process alternatives. (b) Engineering follow-through in an early phase of commercial production. (c) Legal work in connection with patent applications or litigation, and the sale or licensing of patents.
22. Indicate the proper accounting for the following items. (a) Organization costs. (b) Advertising costs. (c) Operating losses.
23. In 2011, Austin Powers Corporation developed a new product that will be marketed in 2012. In connection with the development of this product, the following costs were incurred in 2011: research and development costs $400,000; materials and supplies consumed $60,000; and compensation paid to research consultants $125,000. It is anticipated that these costs will be recovered in 2014. What is the amount of research and development costs that Austin Powers should record in 2011 as a charge to expense?
24. Recently, a group of university students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct?
25. An intangible asset with an estimated useful life of 30 years was acquired on January 1, 2002, for $540,000. On January 1, 2012, a review was made of intangible assets and their expected service lives, and it was determined that this asset had an estimated useful life of 30 more years from the date of the review. What is the amount of amortization for this intangible in 2012?
* 2 6. An article in the financial press stated, “More than half of software maker Comserve’s net worth is in a pile of tapes and ring-bound books. That raises some accountants’ eyebrows.” What is the profession’s position regarding the incurrence of costs for computer software that will be sold?
* 27. Garfunkel, Inc. has incurred $6 million in developing a computer software product for sale to third parties. Of the $6 million costs incurred, $4.5 million is capitalized. The product produced from this development work has generated $2 million of revenue in 2012 and is anticipated to generate another $8 million in future years. The estimated useful life of the project is 4 years. How much of the capitalized costs should be amortized in 2012?
* 28. In 2012, EZ-Learn Software developed a software package for assisting calculus instruction in business colleges, at a cost of $2,000,000. Although there are tens of thousands of calculus students in the market, college instructors seem to change their minds frequently on the use of teaching aids. Not one package has yet been ordered or delivered. Prepare an argument to advocate expensing the development cost in the current year. Offer an argument for capitalizing the development cost over its estimated useful life. Which stakeholders are harmed or benefited by either approach? BRI E F EXERCI S E S
BE12-1 Celine Dion Corporation purchases a patent from Salmon Company on January 1, 2012, for $54,000. The patent has a remaining legal life of 16 years. Celine Dion feels the patent will be useful for 10 years. Prepare Celine Dion’s journal entries to record the purchase of the patent and 2012 amortization.
BE12-2 Use the information provided in
BE12-1. Assume that at January 1, 2014, the carrying amount of the patent on Celine Dion’s books is $43,200. In January, Celine Dion spends $24,000 successfully defending a patent suit. Celine Dion still feels the patent will be useful until the end of 2021. Prepare the journal entries to record the $24,000 expenditure and 2014 amortization.
BE12-3 Larry Byrd, Inc., spent $68,000 in attorney fees while developing the trade name of its new product, the Mean Bean Machine. Prepare the journal entries to record the $68,000 expenditure and the first year’s amortization, using an 8-year life.
BE12-4 Gershwin Corporation obtained a franchise from Sonic Hedgehog Inc. for a cash payment of $120,000 on April 1, 2012. The franchise grants Gershwin the right to sell certain products and services for a period of 8 years. Prepare Gershwin’s April 1 journal entry and December 31 adjusting entry.
BE12-5 On September 1, 2012, Winans Corporation acquired Aumont Enterprises for a cash payment of $700,000. At the time of purchase, Aumont’s balance sheet showed assets of $620,000, liabilities of $200,000, and owners’ equity of $420,000. The fair value of Aumont’s assets is estimated to be $800,000. Compute the amount of goodwill acquired by Winans.
BE12-6 Kenoly Corporation owns a patent that has a carrying amount of $300,000. Kenoly expects future net cash flows from this patent to total $210,000. The fair value of the patent is $110,000. Prepare Kenoly’s journal entry, if necessary, to record the loss on impairment.
BE12-7 Waters Corporation purchased Johnson Company 3 years ago and at that time recorded goodwill of $400,000. The Johnson Division’s net assets, including the goodwill, have a carrying amount of $800,000. The fair value of the division is estimated to be $1,000,000. Prepare Waters’s journal entry, if necessary, to record impairment of the goodwill.
BE12-8 Use the information provided in
BE12-7. Assume that the fair value of the division is estimated to be $750,000 and the implied goodwill is $350,000. Prepare Waters’s journal entry, if necessary, to record impairment of the goodwill.
BE12-9 Capriati Corporation commenced operations in early 2012. The corporation incurred $60,000 of costs such as fees to underwriters, legal fees, state fees, and promotional expenditures during its formation. Prepare journal entries to record the $60,000 expenditure and 2012 amortization, if any.
BE12-10 Treasure Land Corporation incurred the following costs in 2012. Cost of laboratory research aimed at discovery of new knowledge $120,000 Cost of testing in search for product alternatives 100,000 Cost of engineering activity required to advance the design of a product to the manufacturing stage 210,000 $430,000 Prepare the necessary 2012 journal entry or entries for Treasure Land.
BE12-11 Indicate whether the following items are capitalized or expensed in the current year. (a) Purchase cost of a patent from a competitor. (b) Research and development costs. (c) Organizational costs. (d) Costs incurred internally to create goodwill.
BE12-12 Nieland Industries had one patent recorded on its books as of January 1, 2012. This patent had a book value of $288,000 and a remaining useful life of 8 years. During 2012, Nieland incurred research and development costs of $96,000 and brought a patent infringement suit against a competitor. On December 1, 2012, Nieland received the good news that its patent was valid and that its competitor could not use the process Nieland had patented. The company incurred $85,000 to defend this patent. At what amount should patent(s) be reported on the December 31, 2012, balance sheet, assuming monthly amortization of patents?
BE12-13 Sinise Industries acquired two copyrights during 2012. One copyright related to a textbook that was developed internally at a cost of $9,900. This textbook is estimated to have a useful life of 3 years from September 1, 2012, the date it was published. The second copyright (a history research textbook) was purchased from University Press on December 1, 2012, for $24,000. This textbook has an indefinite useful life. How should these two copyrights be reported on Sinise’s balance sheet as of December 31, 2012? *B E12-14 Karen Austin Corporation has capitalized software costs of $800,000, and sales of this product the first year totaled $420,000. Karen Austin anticipates earning $980,000 in additional future revenues from this product, which is estimated to have an economic life of 4 years. Compute the amount of software cost amortization for the first year. 2 3 EXERCI S E S
E12-1 (Classification Issues—Intangibles) Presented below is a list of items that could be included in the intangible assets section of the balance sheet. 1. Investment in a subsidiary company. 2. Timberland. 3. Cost of engineering activity required to advance the design of a product to the manufacturing stage. 4. Lease prepayment (6 months’ rent paid in advance). 5. Cost of equipment obtained. 6. Cost of searching for applications of new research findings. 7. Costs incurred in the formation of a corporation. 8. Operating losses incurred in the start-up of a business. 9. Training costs incurred in start-up of new operation. 10. Purchase cost of a franchise. 11. Goodwill generated internally. 12. Cost of testing in search for product alternatives. 13. Goodwill acquired in the purchase of a business. 14. Cost of developing a patent. 15. Cost of purchasing a patent from an inventor. 16. Legal costs incurred in securing a patent. 17. Unrecovered costs of a successful legal suit to protect the patent. 18. Cost of conceptual formulation of possible product alternatives. 19. Cost of purchasing a copyright. 20. Research and development costs. 21. Long-term receivables. 22. Cost of developing a trademark. 23. Cost of purchasing a trademark.
Instructions (a) Indicate which items on the list above would generally be reported as intangible assets in the balance sheet. (b) Indicate how, if at all, the items not reportable as intangible assets would be reported in the financial statements.
E12-2 (Classification Issues—Intangibles) Presented below is selected information related to Matt Perry Inc. as of December 21, 2012. All these items have debit balances. Cable television franchises Film contract rights Music copyrights Customer lists Research and development costs Prepaid expenses Goodwill Covenants not to compete Cash Brand names Discount on notes payable Notes receivable Accounts receivable Investments in affiliated companies Property, plant, and equipment Organization costs Internet domain name Land
Instructions Identify which items should be classified as an intangible asset. For those items not classified as an intangible asset, indicate where they would be reported in the financial statements.
E12-3 (Classification Issues—Intangible Asset) Langrova Inc. has the following amounts included in its general ledger at December 31, 2012. Organization costs $24,000 Trademarks 20,000 Discount on bonds payable 35,000 Deposits with advertising agency for ads to promote goodwill of company 10,000 Excess of cost over fair value of net identifi able assets of acquired subsidiary 75,000 Cost of equipment acquired for research and development projects; the equipment has an alternative future use 90,000 Costs of developing a secret formula for a product that is expected to be marketed for at least 20 years 70,000
Instructions (a) On the basis of this information, compute the total amount to be reported by Langrova for intangible assets on its balance sheet at December 31, 2012. Equipment has alternative future use. (b) If an item is not to be included in intangible assets, explain its proper treatment for reporting purposes.
E12-4 (Intangible Amortization) Presented below is selected information for Palmiero Company. 1. Palmiero purchased a patent from Vania Co. for $1,500,000 on January 1, 2010. The patent is being amortized over its remaining legal life of 10 years, expiring on January 1, 2020. During 2012, Palmiero determined that the economic benefits of the patent would not last longer than 6 years from the date of acquisition. What amount should be reported in the balance sheet for the patent, net of accumulated amortization, at December 31, 2012? 2. Palmiero bought a franchise from Dougherty Co. on January 1, 2011, for $350,000. The carrying amount of the franchise on Dougherty’s books on January 1, 2011, was $500,000. The franchise agreement had an estimated useful life of 30 years. Because Palmiero must enter a competitive bidding at the end of 2020, it is unlikely that the franchise will be retained beyond 2020. What amount should be amortized for the year ended December 31, 2012? 3. On January 1, 2010, Palmiero incurred organization costs of $275,000. What amount of organization expense should be reported in 2012? 4. Palmiero purchased the license for distribution of a popular consumer product on January 1, 2012, for $150,000. It is expected that this product will generate cash flows for an indefinite period of time. The license has an initial term of 5 years but by paying a nominal fee, Palmiero can renew the license indefinitely for successive 5-year terms. What amount should be amortized for the year ended December 31, 2012?
Instructions Answer the questions asked about each of the factual situations.
E12-5 (Correct Intangible Asset Account) As the recently appointed auditor for Hillary Corporation, you have been asked to examine selected accounts before the 6-month financial statements of June 30, 2012, are prepared. The controller for Hillary Corporation mentions that only one account is kept for intangible assets. Intangible Assets Debit Credit Balance Jan. 4 Research and development costs 940,000 940,000 Jan. 5 Legal costs to obtain patent 75,000 1,015,000 Jan. 31 Payment of 7 months’ rent on property leased by Hillary 91,000 1,106,000 Feb. 11 Premium on common stock 250,000 856,000 March 31 Unamortized bond discount on bonds due March 31, 2032 84,000 940,000 April 30 Promotional expenses related to start-up of business 207,000 1,147,000 June 30 Operating losses for fi rst 6 months 141,000 1,288,000
Instructions Prepare the entry or entries necessary to correct this account. Assume that the patent has a useful life of 12 years.
E12-6 (Recording and Amortization of Intangibles) Powerglide Company, organized in 2011, has set up a single account for all intangible assets. The following summary discloses the debit entries that have been recorded during 2012. 1/2/12 Purchased patent (8-year life) $ 380,000 4/1/12 Goodwill (indefi nite life) 360,000 7/1/12 Purchased franchise with 10-year life; expiration date 7/1/22 450,000 8/1/12 Payment of copyright (5-year life) 156,000 9/1/12 Research and development costs 215,000 $1,561,000
Instructions Prepare the necessary entries to clear the Intangible Assets account and to set up separate accounts for distinct types of intangibles. Make the entries as of December 31, 2012, recording any necessary amortization and reflecting all balances accurately as of that date. (Use straight-line amortization.) 2 3
E12-7 (Accounting for Trade Name) In early January 2011, Reymont Corporation applied for a trade name, incurring legal costs of $18,000. In January 2012, Reymont incurred $7,800 of legal fees in a successful defense of its trade name.
Instructions (a) Compute 2011 amortization, 12/31/11 book value, 2012 amortization, and 12/31/12 book value if the company amortizes the trade name over 10 years. (b) Compute the 2012 amortization and the 12/31/12 book value, assuming that at the beginning of 2012, Reymont determines that the trade name will provide no future benefits beyond December 31, 2015. (c) Ignoring the response for part (b), compute the 2013 amortization and the 12/31/13 book value, assuming that at the beginning of 2013, based on new market research, Reymont determines that the fair value of the trade name is $16,000. Estimated total future cash flows from the trade name is $17,000 on January 3, 2013.
E12-8 (Accounting for Organization Costs) Fontenot Corporation was organized in 2011 and began operations at the beginning of 2012. The company is involved in interior design consulting services. The following costs were incurred prior to the start of operations. Attorney’s fees in connection with organization of the company $17,000 Purchase of drafting and design equipment 10,000 Costs of meetings of incorporators to discuss organizational activities 7,000 State fi ling fees to incorporate 1,000 $35,000
Instructions (a) Compute the total amount of organization costs incurred by Fontenot. (b) Prepare the journal entry to record organization costs for 2012.
E12-9 (Accounting for Patents, Franchises, and R&D) Devon Harris Company has provided information on intangible assets as follows. A patent was purchased from Bradtke Company for $2,500,000 on January 1, 2011. Harris estimated the remaining useful life of the patent to be 10 years. The patent was carried in Bradtke’s accounting records at a net book value of $2,000,000 when Bradtke sold it to Harris. During 2012, a franchise was purchased from Greene Company for $580,000. In addition, 5% of revenue from the franchise must be paid to Greene. Revenue from the franchise for 2012 was $2,500,000. Harris estimates the useful life of the franchise to be 10 years and takes a full year’s amortization in the year of purchase. Harris incurred research and development costs in 2012 as follows. Materials and equipment $142,000 Personnel 189,000 Indirect costs 102,000 $433,000 Harris estimates that these costs will be recouped by December 31, 2015. The materials and equipment purchased have no alternative uses. On January 1, 2012, because of recent events in the field, Harris estimates that the remaining life of the patent purchased on January 1, 2011, is only 5 years from January 1, 2012.
Instructions (a) Prepare a schedule showing the intangibles section of Harris’s balance sheet at December 31, 2012. Show supporting computations in good form. (b) Prepare a schedule showing the income statement effect for the year ended December 31, 2012, as a result of the facts above. Show supporting computations in good form. (AICPA adapted)
E12-10 (Accounting for Patents) During 2009, Thompson Corporation spent $170,000 in research and development costs. As a result, a new product called the New Age Piano was patented. The patent was obtained on October 1, 2009, and had a legal life of 20 years and a useful life of 10 years. Legal costs of $24,000 related to the patent were incurred as of October 1, 2009.
Instructions (a) Prepare all journal entries required in 2009 and 2010 as a result of the transactions above. (b) On June 1, 2011, Thompson spent $12,400 to successfully prosecute a patent infringement suit. As a result, the estimate of useful life was extended to 12 years from June 1, 2011. Prepare all journal entries required in 2011 and 2012. (c) In 2013, Thompson determined that a competitor’s product would make the New Age Piano obsolete and the patent worthless by December 31, 2014. Prepare all journal entries required in 2013 and 2014.
E12-11 (Accounting for Patents) Reddy Industries has the following patents on its December 31, 2011, balance sheet. Patent Item Initial Cost Date Acquired Useful Life at Date Acquired Patent A $40,800 3/1/08 17 years Patent B $15,000 7/1/09 10 years Patent C $14,400 9/1/10 4 years The following events occurred during the year ended December 31, 2012. 1. Research and development costs of $245,700 were incurred during the year. 2. Patent D was purchased on July 1 for $28,500. This patent has a useful life of 91/2 years. 3. As a result of reduced demands for certain products protected by Patent B, a possible impairment of Patent B’s value may have occurred at December 31, 2012. The controller for Reddy estimates the expected future cash flows from Patent B will be as follows. Year Expected Future Cash Flows 2013 $2,000 2014 2,000 2015 2,000 The proper discount rate to be used for these flows is 8%. (Assume that the cash flows occur at the end of the year.)
Instructions (a) Compute the total carrying amount of Reddy’s patents on its December 31, 2011, balance sheet. (b) Compute the total carrying amount of Reddy’s patents on its December 31, 2012, balance sheet.
E12-12 (Accounting for Goodwill) Fred Graf, owner of Graf Interiors, is negotiating for the purchase of Terrell Galleries. The balance sheet of Terrell is given in an abbreviated form below. TERRELL GALLERIES BALANCE SHEET AS OF DECEMBER 31, 2012 Assets Liabilities and Stockholders’ Equity Cash $100,000 Accounts payable $ 50,000 Land 70,000 Notes payable (long term) 300,000 Buildings (net) 200,000 Total liabilities 350,000 Equipment (net) 175,000 Common stock $200,000 Copyrights (net) 30,000 Retained earnings 25,000 225,000 Total assets $575,000 Total liabilities and stockholders’ equity $575,000 Graf and Terrell agree that: 1. Land is undervalued by $50,000. 2. Equipment is overvalued by $5,000. Terrell agrees to sell the gallery to Graf for $380,000.
Instructions Prepare the entry to record the purchase of Terrell Galleries on Graf’s books.
E12-13 (Accounting for Goodwill) On July 1, 2012, Gissel Corporation purchased Mills Company by paying $250,000 cash and issuing a $150,000 note payable. At July 1, 2012, the balance sheet of Mills Company was as follows. Cash $ 50,000 Accounts payable $200,000 Accounts receivable 90,000 Stockholders’ equity 235,000 Inventory 100,000 $435,000 Land 40,000 Buildings (net) 75,000 Equipment (net) 70,000 Copyrights 10,000 $435,000 The recorded amounts all approximate current values except for land (fair value of $80,000), inventory (fair value of $125,000), and copyrights (fair value of $15,000).
Instructions (a) Prepare the July 1 entry for Gissel Corporation to record the purchase. (b) Prepare the December 31 entry for Gissel Corporation to record amortization of intangibles. The copyright has an estimated useful life of 4 years with a residual value of $3,000.
E12-14 (Copyright Impairment) Presented below is information related to copyrights owned by Botticelli Company at December 31, 2012. Cost $8,600,000 Carrying amount 4,300,000 Expected future net cash fl ows 4,000,000 Fair value 3,400,000 Assume that Botticelli Company will continue to use this copyright in the future. As of December 31, 2012, the copyright is estimated to have a remaining useful life of 10 years.
Instructions (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2012. The company does not use accumulated amortization accounts. (b) Prepare the journal entry to record amortization expense for 2013 related to the copyrights. (c) The fair value of the copyright at December 31, 2013, is $3,400,000. Prepare the journal entry (if any) necessary to record the increase in fair value.
E12-15 (Goodwill Impairment) Presented below is net asset information related to the Mischa Division of Santana, Inc. MISCHA DIVISION NET ASSETS AS OF DECEMBER 31, 2012 (IN MILLIONS) Cash $ 60 Accounts receivable 200 Property, plant, and equipment (net) 2,600 Goodwill 200 Less: Notes payable 2,700 Net assets $ 360 The purpose of the Mischa Division is to develop a nuclear-powered aircraft. If successful, traveling delays associated with refueling could be substantially reduced. Many other benefits would also occur. To date, management has not had much success and is deciding whether a write-down at this time is appropriate. Management estimated its future net cash flows from the project to be $400 million. Management has also received an offer to purchase the division for $335 million. All identifiable assets’ and liabilities’ book and fair value amounts are the same.
Instructions (a) Prepare the journal entry (if any) to record the impairment at December 31, 2012. (b) At December 31, 2013, it is estimated that the division’s fair value increased to $345 million. Prepare the journal entry (if any) to record this increase in fair value.
E12-16 (Accounting for R&D Costs) Margaret Avery Company from time to time embarks on a research program when a special project seems to offer possibilities. In 2011, the company expends $325,000 on a research project, but by the end of 2011 it is impossible to determine whether any benefit will be derived from it.
Instructions (a) What account should be charged for the $325,000, and how should it be shown in the financial statements? (b) The project is completed in 2012, and a successful patent is obtained. The R&D costs to complete the project are $130,000. The administrative and legal expenses incurred in obtaining patent number 472-1001-84 in 2012 total $24,000. The patent has an expected useful life of 5 years. Record these costs in journal entry form. Also, record patent amortization (full year) in 2012. (c) In 2013, the company successfully defends the patent in extended litigation at a cost of $47,200, thereby extending the patent life to December 31, 2020. What is the proper way to account for this cost? Also, record patent amortization (full year) in 2013. (d) Additional engineering and consulting costs incurred in 2013 required to advance the design of a product to the manufacturing stage total $60,000. These costs enhance the design of the product considerably. Discuss the proper accounting treatment for this cost. 9 6 7 7
E12-17 (Accounting for R&D Costs) Martinez Company incurred the following costs during 2012 in connection with its research and development activities. Cost of equipment acquired that will have alternative uses in future R&D projects over the next 5 years (uses straight-line depreciation) $330,000 Materials consumed in R&D projects 59,000 Consulting fees paid to outsiders for R&D projects 100,000 Personnel costs of persons involved in R&D projects 128,000 Indirect costs reasonably allocable to R&D projects 50,000 Materials purchased for future R&D projects 34,000
Instructions Compute the amount to be reported as research and development expense by Martinez on its income statement for 2012. Assume equipment is purchased at the beginning of the year. *
E12-18 (Accounting for Computer Software Costs) Majoli Inc. has capitalized computer software costs of $3,900,000 on its new “Trenton” software package. Revenues from 2012 (first year) sales are $2,000,000. Additional future revenues from “Trenton” for the remainder of its economic life, through 2016, are estimated to be $10,000,000.
Instructions (a) What method or methods of amortization are to be applied in the write-off of capitalized computer software costs? (b) Compute the amount of amortization for 2012 for “Trenton.” *E 12-19 (Accounting for Computer Software Costs) During 2012, Botosan Enterprises Inc. spent $5,000,000 developing its new “Dover” software package. Of this amount, $2,600,000 was spent before technological feasibility was established for the product, which is to be marketed to third parties. The package was completed at December 31, 2012. Botosan expects a useful life of 8 years for this product with total revenues of $16,000,000. During the first year (2013), Botosan realizes revenues of $3,200,000.
Instructions (a) Prepare journal entries required in 2012 for the foregoing facts. (b) Prepare the entry to record amortization at December 31, 2013. (c) At what amount should the computer software costs be reported in the December 31, 2013, balance sheet? Could the net realizable value of this asset affect your answer? (d) What disclosures are required in the December 31, 2013, financial statements for the computer software costs? (e) How would your answers for (a), (b), and (c) be different if the computer software was developed for internal use?
 9 11 11 PROBLEMS
P12-1 (Correct Intangible Asset Account) Reichenbach Co., organized in 2011, has set up a single account for all intangible assets. The following summary discloses the debit entries that have been recorded during 2012 and 2013. Intangible Assets 7/1/12 8-year franchise; expiration date 6/30/19 $ 48,000 10/1/12 Advance payment on laboratory space (2-year lease) 24,000 12/31/12 Net loss for 2011 including state incorporation fee, $1,000, and related legal fees of organizing, $5,000 (all fees incurred in 2011) 16,000 1/2/13 Patent purchased (10-year life) 84,000 3/1/13 Cost of developing a secret formula (indefinite life) 75,000 4/1/13 Goodwill purchased (indefinite life) 278,400 6/1/13 Legal fee for successful defense of patent purchased above 12,650 9/1/13 Research and development costs 160,000
Instructions Prepare the necessary entries to clear the Intangible Assets account and to set up separate accounts for distinct types of intangibles. Make the entries as of December 31, 2013, recording any necessary amortization and reflecting all balances accurately as of that date. (Ignore income tax effects.)
P12-2 (Accounting for Patents) Fields Laboratories holds a valuable patent (No. 758-6002-1A) on a precipitator that prevents certain types of air pollution. Fields does not manufacture or sell the products and processes it develops. Instead, it conducts research and develops products and processes which it patents, and then assigns the patents to manufacturers on a royalty basis. Occasionally it sells a patent. The history of Fields patent number 758-6002-1A is as follows. Date Activity Cost 2003–2004 Research conducted to develop precipitator $384,000 Jan. 2005 Design and construction of a prototype 87,600 March 2005 Testing of models 42,000 Jan. 2006 Fees paid engineers and lawyers to prepare patent application; patent granted June 30, 2006 59,500 Nov. 2007 Engineering activity necessary to advance the design of the precipitator to the manufacturing stage 81,500 Dec. 2008 Legal fees paid to successfully defend precipitator patent 42,000 April 2009 Research aimed at modifying the design of the patented precipitator 43,000 July 2013 Legal fees paid in unsuccessful patent infringement suit against a competitor 34,000 Fields assumed a useful life of 17 years when it received the initial precipitator patent. On January 1, 2011, it revised its useful life estimate downward to 5 remaining years. Amortization is computed for a full year if the cost is incurred prior to July 1, and no amortization for the year if the cost is incurred after June 30. The company’s year ends December 31.
Instructions Compute the carrying value of patent No. 758-6002-1A on each of the following dates: (a) December 31, 2006. (b) December 31, 2010. (c) December 31, 2013.
P12-3 (Accounting for Franchise, Patents, and Trade Name) Information concerning Sandro Corporation’s intangible assets is as follows. 1. On January 1, 2012, Sandro signed an agreement to operate as a franchisee of Hsian Copy Service, Inc. for an initial franchise fee of $75,000. Of this amount, $15,000 was paid when the agreement was signed, and the balance is payable in 4 annual payments of $15,000 each, beginning January 1, 2013. The agreement provides that the down payment is not refundable and no future services are required of the franchisor. The present value at January 1, 2012, of the 4 annual payments discounted at 14% (the implicit rate for a loan of this type) is $43,700. The agreement also provides that 5% of the revenue from the franchise must be paid to the franchisor annually. Sandro’s revenue from the franchise for 2012 was $900,000. Sandro estimates the useful life of the franchise to be 10 years. (Hint: You may want to refer to Appendix 18A to determine the proper accounting treatment for the franchise fee and payments.) 2. Sandro incurred $65,000 of experimental and development costs in its laboratory to develop a patent that was granted on January 2, 2012. Legal fees and other costs associated with registration of the patent totaled $17,600. Sandro estimates that the useful life of the patent will be 8 years. 3. A trademark was purchased from Shanghai Company for $36,000 on July 1, 2009. Expenditures for successful litigation in defense of the trademark totaling $10,200 were paid on July 1, 2012. Sandro estimates that the useful life of the trademark will be 20 years from the date of acquisition.
Instructions (a) Prepare a schedule showing the intangible assets section of Sandro’s balance sheet at December 31, 2012. Show supporting computations in good form. (b) Prepare a schedule showing all expenses resulting from the transactions that would appear on Sandro’s income statement for the year ended December 31, 2012. Show supporting computations in good form. (AICPA adapted) 2 3 2 3
P12-4 (Accounting for R&D Costs) During 2010, Robin Wright Tool Company purchased a building site for its proposed research and development laboratory at a cost of $60,000. Construction of the building was started in 2010. The building was completed on December 31, 2011, at a cost of $320,000 and was placed in service on January 2, 2012. The estimated useful life of the building for depreciation purposes was 20 years. The straight-line method of depreciation was to be employed, and there was no estimated salvage value. Management estimates that about 50% of the projects of the research and development group will result in long-term benefits (i.e., at least 10 years) to the corporation. The remaining projects either benefit the current period or are abandoned before completion. A summary of the number of projects and the direct costs incurred in conjunction with the research and development activities for 2012 appears below. Salaries and Other Expenses Number Employee (excluding Building of Projects Benefits Depreciation Charges) Completed projects with long-term benefits 15 $ 90,000 $50,000 Abandoned projects or projects that benefit the current period 10 65,000 15,000 Projects in process—results indeterminate 5 40,000 12,000 Total 30 $195,000 $77,000 Upon recommendation of the research and development group, Robin Wright Tool Company acquired a patent for manufacturing rights at a cost of $88,000. The patent was acquired on April 1, 2011, and has an economic life of 10 years.
Instructions If generally accepted accounting principles were followed, how would the items above relating to research and development activities be reported on the following financial statements? (a) The company’s income statement for 2012. (b) The company’s balance sheet as of December 31, 2012. Be sure to give account titles and amounts, and briefly justify your presentation. (CMA adapted)
P12-5 (Goodwill, Impairment) On July 31, 2012, Mexico Company paid $3,000,000 to acquire all of the common stock of Conchita Incorporated, which became a division of Mexico. Conchita reported the following balance sheet at the time of the acquisition. Current assets $ 800,000 Current liabilities $ 600,000 Noncurrent assets 2,700,000 Long-term liabilities 500,000 Total assets $3,500,000 Stockholders’ equity 2,400,000 Total liabilities and stockholders’ equity $3,500,000 It was determined at the date of the purchase that the fair value of the identifiable net assets of Conchita was $2,750,000. Over the next 6 months of operations, the newly purchased division experienced operating losses. In addition, it now appears that it will generate substantial losses for the foreseeable future. At December 31, 2012, Conchita reports the following balance sheet information. Current assets $ 450,000 Noncurrent assets (including goodwill recognized in purchase) 2,400,000 Current liabilities (700,000) Long-term liabilities (500,000) Net assets $1,650,000 It is determined that the fair value of the Conchita Division is $1,850,000. The recorded amount for Conchita’s net assets (excluding goodwill) is the same as fair value, except for property, plant, and equipment, which has a fair value $150,000 above the carrying value.
Instructions (a) Compute the amount of goodwill recognized, if any, on July 31, 2012. (b) Determine the impairment loss, if any, to be recorded on December 31, 2012. (c) Assume that fair value of the Conchita Division is $1,600,000 instead of $1,850,000. Determine the impairment loss, if any, to be recorded on December 31, 2012. (d) Prepare the journal entry to record the impairment loss, if any, and indicate where the loss would be reported in the income statement.
P12-6 (Comprehensive Intangible Assets) Montana Matt’s Golf Inc. was formed on July 1, 2011, when Matt Magilke purchased the Old Master Golf Company. Old Master provides video golf instruction at kiosks in shopping malls. Magilke plans to integrate the instructional business into his golf equipment and accessory stores. Magilke paid $770,000 cash for Old Master. At the time, Old Master’s balance sheet reported assets of $650,000 and liabilities of $200,000 (thus owners’ equity was $450,000). The fair value of Old Master’s assets is estimated to be $800,000. Included in the assets is the Old Master trade name with a fair value of $10,000 and a copyright on some instructional books with a fair value of $24,000. The trade name has a remaining life of 5 years and can be renewed at nominal cost indefinitely. The copyright has a remaining life of 40 years.
Instructions (a) Prepare the intangible assets section of Montana Matt’s Golf Inc. at December 31, 2011. How much amortization expense is included in Montana Matt’s income for the year ended December 31, 2011? Show all supporting computations. (b) Prepare the journal entry to record amortization expense for 2012. Prepare the intangible assets section of Montana Matt’s Golf Inc. at December 31, 2012. (No impairments are required to be recorded in 2012.) (c) At the end of 2013, Magilke is evaluating the results of the instructional business. Due to fierce competition from online and television (e.g., the Golf Channel), the Old Master reporting unit has been losing money. Its book value is now $500,000. The fair value of the Old Master reporting unit is $420,000. The implied value of goodwill is $90,000. Magilke has collected the following information related to the company’s intangible assets. Expected Cash Flows Intangible Asset (undiscounted) Fair Values Trade names $ 9,000 $ 3,000 Copyrights 30,000 25,000 Prepare the journal entries required, if any, to record impairments on Montana Matt’s intangible assets. (Assume that any amortization for 2013 has been recorded.) Show supporting computations. 2 3 6 7 10 CONCEPTS FOR ANALYS I S
CA12-1 (Accounting for Pollution Expenditure) Counting Crows Company operates several plants at which limestone is processed into quicklime and hydrated lime. The Eagle Ridge plant, where most of the equipment was installed many years ago, continually deposits a dusty white substance over the surrounding countryside. Citing the unsanitary condition of the neighboring community of Scales Mound, the pollution of the Galena River, and the high incidence of lung disease among workers at Eagle Ridge, the state’s Pollution Control Agency has ordered the installation of air pollution control equipment. Also, the agency has assessed a substantial penalty, which will be used to clean up Scales Mound. After considering the costs involved (which could not have been reasonably estimated prior to the agency’s action), Counting Crows Company decides to comply with the agency’s orders, the alternative being to cease operations at Eagle Ridge at the end of the current fiscal year. The officers of Counting Crows agree that the air pollution control equipment should be capitalized and depreciated over its useful life, but they disagree over the period(s) to which the penalty should be charged.
Instructions Discuss the conceptual merits and reporting requirements of accounting for the penalty in each of the following ways. (a) As a charge to the current period. (b) As a correction of prior periods. (c) As a capitalizable item to be amortized over future periods. (AICPA adapted)
CA12-2 (Accounting for Pre-Opening Costs) After securing lease commitments from several major stores, Auer Shopping Center, Inc. was organized and built a shopping center in a growing suburb. The shopping center would have opened on schedule on January 1, 2012, if it had not been struck by a severe tornado in December. Instead, it opened for business on October 1, 2012. All of the additional construction costs that were incurred as a result of the tornado were covered by insurance. In July 2011, in anticipation of the scheduled January opening, a permanent staff had been hired to promote the shopping center, obtain tenants for the uncommitted space, and manage the property. A summary of some of the costs incurred in 2011 and the first nine months of 2012 follows. January 1, 2012 through 2011 September 30, 2012 Interest on mortgage bonds $720,000 $540,000 Cost of obtaining tenants 300,000 360,000 Promotional advertising 540,000 557,000 The promotional advertising campaign was designed to familiarize shoppers with the center. Had it been known in time that the center would not open until October 2012, the 2011 expenditure for promotional advertising would not have been made. The advertising had to be repeated in 2012. All of the tenants who had leased space in the shopping center at the time of the tornado accepted the October occupancy date on condition that the monthly rental charges for the first 9 months of 2012 be canceled.
Instructions Explain how each of the costs for 2011 and the first 9 months of 2012 should be treated in the accounts of the shopping center corporation. Give the reasons for each treatment. (AICPA adapted)

CA12-3 (Accounting for Patents) On June 30, 2012, your client, Ferry Company, was granted two patents covering plastic cartons that it had been producing and marketing profitably for the past 3 years. One patent covers the manufacturing process, and the other covers the related products. Ferry executives tell you that these patents represent the most significant breakthrough in the industry in the past 30 years. The products have been marketed under the registered trademarks Evertight, Duratainer, and Sealrite. Licenses under the patents have already been granted by your client to other manufacturers in the United States and abroad and are producing substantial royalties. On July 1, Ferry commenced patent infringement actions against several companies whose names you recognize as those of substantial and prominent competitors. Ferry’s management is optimistic that these suits will result in a permanent injunction against the manufacture and sale of the infringing products as well as collection of damages for loss of profits caused by the alleged infringement. The financial vice president has suggested that the patents be recorded at the discounted value of expected net royalty receipts.
Instructions (a) What is the meaning of “discounted value of expected net receipts”? Explain. (b) How would such a value be calculated for net royalty receipts? (c) What basis of valuation for Ferry’s patents would be generally accepted in accounting? Give supporting reasons for this basis. (d) Assuming no practical problems of implementation, and ignoring generally accepted accounting principles, what is the preferable basis of valuation for patents? Explain. (e) What would be the preferable theoretical basis of amortization? Explain. (f) What recognition, if any, should be made of the infringement litigation in the financial statements for the year ending September 30, 2012? Discuss. (AICPA adapted)

CA12-4 (Accounting for Research and Development Costs) Cuevas Co. is in the process of developing a revolutionary new product. A new division of the company was formed to develop, manufacture, and market this new product. As of year-end (December 31, 2012), the new product has not been manufactured for resale. However, a prototype unit was built and is in operation. Throughout 2012, the new division incurred certain costs. These costs include design and engineering studies, prototype manufacturing costs, administrative expenses (including salaries of administrative personnel), and market research costs. In addition, approximately $900,000 in equipment (with an estimated useful life of 10 years) was purchased for use in developing and manufacturing the new product. Approximately $315,000 of this equipment was built specifically for the design development of the new product. The remaining $585,000 of equipment was used to manufacture the pre-production prototype and will be used to manufacture the new product once it is in commercial production.
Instructions (a) How are “research” and “development” defined in the authoritative literature (GAAP)? (b) Briefly indicate the practical and conceptual reasons for the conclusion reached by the Financial Accounting Standards Board on accounting and reporting practices for research and development costs. (c) In accordance with GAAP, how should the various costs of Cuevas described above be recorded on the financial statements for the year ended December 31, 2012? (AICPA adapted)
CA12-5 (Accounting for Research and Development Costs) Czeslaw Corporation’s research and development department has an idea for a project it believes will culminate in a new product that would be very profitable for the company. Because the project will be very expensive, the department requests approval from the company’s controller, Jeff Reid. Reid recognizes that corporate profits have been down lately and is hesitant to approve a project that will incur significant expenses that cannot be capitalized due to the requirements of the authoritative literature. He knows that if they hire an outside firm that does the work and obtains a patent for the process, Czeslaw Corporation can purchase the patent from the outside firm and record the expenditure as an asset. Reid knows that the company’s own R&D department is first-rate, and he is confident they can do the work well.
Instructions Answer the following questions. (a) Who are the stakeholders in this situation? (b) What are the ethical issues involved? (c) What should Reid do? USING YOUR JUDGMENT
FINANCIAL REPORTING

Financial Reporting Problem

The Procter & Gamble Company (P&G)
The financial statements of P&G are presented in Appendix 5B or can be accessed at the book’s companion website, www.wiley.com/college/kieso.
Instructions Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) Does P&G report any intangible assets, especially goodwill, in its 2009 financial statements and accompanying notes? (b) How much research and development (R&D) cost was expensed by P&G in 2009 and 2008? What percentage of sales revenue and net income did P&G spend on R&D in 2009 and 2008?
Comparative Analysis Case
The Coca-Cola Company and PepsiCo, Inc.
Instructions Go to the book’s companion website and use information found there to answer the following questions related to The Coca-Cola Company and PepsiCo, Inc. (a) (1) What amounts for intangible assets were reported in their respective balance sheets by Coca-Cola and PepsiCo? (2) What percentage of total assets is each of these reported amounts? (3) What was the change in the amount of intangibles from 2008 to 2009 for Coca-Cola and PepsiCo? (b) (1) On what basis and over what periods of time did Coca-Cola and PepsiCo amortize their intangible assets? (2) What were the amounts of accumulated amortization reported by Coca-Cola and PepsiCo at the end of 2009 and 2008? (3) What was the composition of the identifi able and unidentifi able intangible assets reported by Coca-Cola and PepsiCo at the end of 2009? Using Your Judgment 709 Company Sprint Nextel Washington Mutual E* Trade Financial $36,361 11,742 1,639 $51,271 23,941 4,104 $30,718 9,062 2,035 3.5% 2.4% 5.6% Fair Value of Company Book Value (Net Assets) Carrying Value of Goodwill Return on Assets
Financial Statement Analysis Cases

Case 1: Merck and Johnson & Johnson
Merck & Co., Inc. and Johnson & Johnson are two leading producers of healthcare products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of a new healthcare product is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and $200 million to develop its 1-DAY ACUVUE contact lenses. Below are some basic data compiled from the financial statements of these two companies. (all dollars in millions) Johnson & Johnson Merck Total assets $53,317 $42,573 Total revenue 47,348 22,939 Net income 8,509 5,813 Research and development expense 5,203 4,010 Intangible assets 11,842 2,765
Instructions (a) What kinds of intangible assets might a healthcare products company have? Does the composition of these intangibles matter to investors—that is, would it be perceived differently if all of Merck’s intangibles were goodwill, than if all of its intangibles were patents? (b) Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditures the company could have reported $1.3 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditures for at least a couple of years. What would you advise? (c) The notes to Merck’s financial statements note that Merck has goodwill of $1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on your books?
Case 2: Analysis of Goodwill
As a new intern for the local branch office of a national brokerage firm, you are excited to get an assignment that allows you to use your accounting expertise. Your supervisor provides you the spreadsheet below, which contains data for the most recent quarter for three companies that the firm has been recommending to it clients as “buys.” Each of the companies’ returns on assets has outperformed their industry cohorts in the past, but given recent challenges in their markets, there is concern that the companies may experience operating challenges and lower earnings. (All numbers in millions, except return on assets.)
Instructions (a) The fair value for each of these companies is lower than the corresponding book value. What implications does this have for each company’s future prospects? (b) To date, none of these companies has recorded goodwill impairments. Your supervisor suspects that they will need to record impairments in the near future, but he is unsure about the goodwill impairment rules. Is it likely that these companies will recognize impairments? Explain. (c) Using the data on the previous page, estimate the amount of goodwill impairment for each company and prepare the journal entry to record the impairment. For each company, you may assume that the book value less the carrying value of the goodwill approximates the fair value of the companies’ net assets. (d) Discuss the effects of your entries in part (c) on your evaluation of these companies based on the return on assets ratio.




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